Russia’s mortgage boom

Written by Andrey Vakulenko – MACON Realty Group, EECFA Russia

The Russian residential market will long be the driving force behind the whole construction sector due to the continued high demand of most of the country’s population for improving their housing conditions. Mortgage loans, the most common means for purchasing homes in Russia in recent years, have finally strengthened, which compensates for the crisis years of 2015-2016 in Russia. As there has been a major drop in the population’s income, and it persists, mortgage lending is the only way to increase home purchases. The mortgage market easily overcame the crisis of 2015-2016 in Russia and already in 2017 exceeded the peak indicators of the pre-crisis year of 2014. During the first half of 2018, the trend towards growth further strengthened: the volume of issued mortgage loans rose by 68%, and its share in the total number of housing transactions reached a record 54% in the primary market. All this shows the current high demand for mortgage loans.

To explain the explosive growth in mortgage lending, the fundamental factors shaping the housing market need to be considered:

  1. Level of individuals’ living space provision (sqm/person);
  2. Demand for housing (how much more housing needs to be built, so that the level of living space provision can reach an acceptable value – about 30 sqm per person);
  3. Affordability of housing for purchase (the ratio of the income of buyers and the price of real estate).

As per the Federal State Statistics Service of the Russian Federation, to date, the total housing stock in Russia is about 3.4 billion sqm, only slightly more than 23 sq km in terms of the country’s permanent population (146.9 million as of January 1, 2018) per person. This level can be considered low compared to most developed foreign countries (39 sqm/person in France and Germany; 70 sqm/person in the USA, 76 sqm/person in Canada). Minimally comfortable living conditions are achieved with a security level of at least 30 sqm/person as per the social standards of the United Nations, and it is the target of public housing programs in Russia. To ensure that the population’s living space has reached this target, while maintaining the country’s population at the current level, another 1.0 billion sqm of living space should be built. Thus, the low level of housing provision is the guarantor of the preservation of demand for new housing projects for a long term.

The second factor ensuring long-term demand for housing is the quality of the existing housing stock, which has more than 33% (or about 1.2 billion sqm) of housing built before 1970. Even with the record volumes of housing construction registered in Russia in recent years (in 2014-2017 about 80 million sqm annually) and even if it stays at the current level, it will still take at least 28 years to reach the minimum acceptable security and to fully replace the old housing stock. In general, housing demand in Russia will not be satisfied in the next two or three decades, but now it is especially acute. The low level of security and dilapidation of a large part of the housing stock create uncomfortable conditions for the lives of many Russians. Today about 45% of Russian families want to improve their housing conditions (as per the study conducted by DOM.RF, the Agency for Housing Mortgage Lending) for reasons such as the insufficient area, the low level of comfort in their homes or their state of emergency.

Only about 12 million families in Russia plan to purchase housing in the next five years (as per the survey conducted by the Russian Public Opinion Research Center in 2017).  If we translate this into residential area, it is a potential demand for 665 million sqm of housing (evaluation by DOM.RF). However, this demand will never be realized if housing is not affordable to individuals. The affordability indicator is determined by the ratio of the income level of individuals and housing prices. In fact, the average availability of housing in recent years has not changed significantly, remaining at a fairly low level (the growth of nominal incomes occurred in proportion to the rise in housing costs), and in these circumstances, the actual opportunity to purchase own housing in Russia is directly dependent on the availability of mortgage lending.

Between 2004 and 2017 the volume of mortgage loans increased by more than 33 times (source: DOM.RF): more than 7 million families purchased housing on mortgage. The mortgage market in general has developed quite stably and dynamically and the positive dynamics in the volume of mortgage loans was only interrupted during the global macroeconomic shocks: in the global financial crisis of 2008-2009 and the currency crisis in Russia in 2014-2015 (when the mortgage market demonstrated a much greater stability). In the former crisis, the volume of issued mortgage loans in monetary terms shrank immediately by 76%, while in the latter one, the market declined by 35%. Operative government intervention and a program to subsidize mortgage lending helped the market to overcome the negative period and by the end of 2017 the peak figures registered in 2014 had been reached and exceeded: in Russia in 2017, about 1 million mortgage loans were issued for more than RUB 2 trillion, showing a market recovery in less than 3 years.

During the first 7 months of 2018, the population’s interest in mortgages continues to grow. As per the preliminary estimate of DOM.RF and Frank RG, about 785000 loans worth more than RUB 1.55 trillion have been issued, 68% higher than in the same period last year. For 10 months (since October 2017), the monthly growth rate in the mortgage market volume has been 60% over the previous year. The volume of issued mortgages for January-July 2018 is already higher than the figures for the whole 2016 (RUB 1.47 trillion). DOM.RF estimates that the record issuance in 2017 (RUB 2.03 trillion) can be broken already by the results of 9 months of 2018. DOM.RF forecasts that in case stable macroeconomic dynamics are maintained, in 2018 about 1.5 million mortgage loans in total on more than RUB 3 trillion can be granted, which is 1.4 times and 1.5 times more than the 2017 level, respectively.

Besides the low affordability of housing and high housing demand, the driver of the Russian mortgage market growth is a steady negative dynamics in mortgage rates. This year rates continued to decline and in the first 7 months their average level was 9.6%. By the end of 2018, it is most likely to reach 9.0%. Lowering rates make mortgages more affordable, largely compensating for the drop in the real income of the population (taking into account inflation) in 2014-2016. The ability to take up a mortgage is granted to individuals who previously could not obtain one due to the lack of income. In addition, mortgages at lower rates become a real alternative to rental housing, which also contributes to the growth of the number of potential borrowers. On the one hand, an affordable mortgage stimulates demand, which is necessary for the stable development of the housing market. On the other hand, the mortgage boom obviously creates potential risks. In addition to directly reducing of interest rates, banks in Russia are gradually easing loan conditions, in particular, the necessary amount of down payment. At the end of 2017, about 1/3 of all issued loans had a down payment of less than 20%. And the average loan period is steadily growing. This situation reduces the reliability of the mortgage loan portfolio.

It is still premature to talk about a market bubble, though. Under any sharp deterioration in the macroeconomic situation in Russia and falling incomes of the population, however, it is such long-term loans with a minimum down payment that will become irrevocable in the first place. Problems in the mortgage market might also arise because of the interest rate risk of banks issuing loans at fixed rates for extremely long periods. With a hike in inflation and a rise in the key rate, mortgage loan portfolios may become unprofitable.

But these risks now are only hypothetical and their realization in the near future cannot be foreseen. According to DOM.RF, the share of overdue mortgage debt is steadily decreasing and amounts to only about 2% of all loans, which makes mortgage lending the best segment of lending to individuals in Russia in terms of asset quality. In non-mortgage loans, for example, the share of overdue debt exceeds 12% today.

In the next few years, the most likely scenario for mortgage lending in Russia is a continuing rise in volume indicators. The positive dynamics will contribute to the increased availability of mortgages associated with the projected rise in real income due to the ongoing reduction of interest rates on mortgage products. The ratio of accumulated mortgage debt to Russia’s GDP, which is only about 5% (source: The World Bank), also indicates a potential for further growth in mortgage volumes as the same ratio in the United Kingdom is 65%, in the USA and Canada it is 61%, in France it is 45% and in Germany it is 42%. At the same time, growth rates in mortgages will gradually decelerate due to the exhaustion of pent-up demand created during the high rates of 2014-2015, and some depletion of the client base i.e. many individuals intending to take up a mortgage loan have already done so.

Around 8.6 million families plan to buy homes on mortgage, and demand for mortgage loans in a five-year perspective is RUB 20 trillion (by DOM.RF). All this, of course, will support housing construction, which is one of the most capacious construction segments in Russia. More details about it can be read in the current EECFA Forecast Report Russia up to 2020. Sample report: eecfa.com / Discount options and orders: eszter.falucskai@eecfa.com.

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